Legal Definitions - AGI

AGI stands for Adjusted Gross Income.

Adjusted Gross Income (AGI) is a crucial figure on an individual's income tax return. It represents your total income from all sources, such as wages, salaries, business profits, investment earnings (like dividends and capital gains), and retirement distributions, minus certain specific deductions allowed by the tax law. These permitted deductions, often called "adjustments to income," are subtracted from your total (gross) income before your final tax liability is calculated.

The resulting AGI is a foundational number because it not only helps determine how much income tax you owe but also influences your eligibility for various tax credits and the limits on other deductions you might claim, such as medical expenses or charitable contributions.

Here are a few examples to illustrate how Adjusted Gross Income (AGI) works:

• Example 1: The Salaried Employee with Retirement Savings

  Imagine Sarah, who earns an annual salary of $70,000 from her job and also receives $1,000 in dividends from her investments. Her total gross income is $71,000. However, Sarah contributes $6,000 to a traditional Individual Retirement Account (IRA) and pays $1,500 in interest on her student loans. Both of these are common "adjustments to income."

  How it illustrates AGI: To calculate her AGI, Sarah subtracts her IRA contribution ($6,000) and her student loan interest ($1,500) from her gross income ($71,000). Her AGI would be $71,000 - $6,000 - $1,500 = $63,500. This lower AGI is the figure the IRS uses to determine her tax bracket and the starting point for calculating her final tax bill, potentially making her eligible for other tax benefits.

• Example 2: The Self-Employed Consultant

  Consider David, a freelance marketing consultant. Last year, he billed clients for a total of $90,000. This is his business income. However, he also incurred $15,000 in legitimate business expenses, such as office supplies, software subscriptions, and professional development courses. Additionally, as a self-employed individual, he paid a portion of his self-employment taxes (Social Security and Medicare) that can be deducted.

  How it illustrates AGI: David's gross income includes his $90,000 in business revenue. Before arriving at his AGI, he can deduct his $15,000 in business expenses and a portion of his self-employment taxes. If that deduction for self-employment taxes was, for instance, $4,000, his AGI would be $90,000 - $15,000 - $4,000 = $71,000. This demonstrates how AGI reflects his income after accounting for the direct costs of earning that income, providing a more accurate picture for tax purposes.

• Example 3: Impact on Deduction Limits

  Maria has an AGI of $50,000. She had significant medical expenses last year, totaling $6,000. The tax law allows taxpayers to deduct medical expenses only if they exceed a certain percentage of their AGI (for example, 7.5% in some years). In Maria's case, 7.5% of her AGI is $3,750 ($50,000 * 0.075).

  How it illustrates AGI: Maria can only deduct the amount of medical expenses that exceeds $3,750. So, she can deduct $6,000 - $3,750 = $2,250. This example clearly shows how AGI acts as a critical threshold. A higher AGI would mean a higher threshold for medical expense deductions, potentially reducing the deductible amount, while a lower AGI would make it easier to deduct more of her medical costs.